The US-China Economic and Security Review Commission has just released its 2017 “Report to Congress.” The Commission’s analysis reveals that Beijing’s meteoric economic rise in recent years is beginning to show some strain and increasing debt. Of particular concern to Americans is the vast deficit the U.S. has in its trade relations, some of which has been generated by China’s unfair trade practices. Perhaps the most worrisome aspect is Beijing’s continued massive growth in military power, and the aggressive nature of Chinese relations with nations within its region. We have excerpted the key findings of the Report, and present them in four parts without comment.
ECONOMICS AND TRADE
In 2016 and the first half of 2017, the Chinese government has reported it met or exceeded the targets it set for gross domestic product (GDP) growth—an important deliverable in advance of the political leadership transitions at the Chinese Communist Party’s 19th Party Congress scheduled for October 2017. The Chinese government has achieved this high growth through reliance on old drivers: credit and real estate. However, the government’s unwillingness to allow the market to play a bigger role has resulted in deteriorating investment efficiency, meaning higher levels of debt are necessary to generate growth. Household consumption—an essential element of China’s economic rebalancing—is growing but at a sluggish pace due to the slow rate of reform.
China’s high and rising debt levels pose a growing threat to the country’s financial stability. China’s total debt reached $27.5 trillion, or 257 percent of GDP, at the end of 2016. The dramatic rise in China’s debt burden can be attributed to the relentless expansion of credit the government has relied on to generate growth since the global financial crisis.
The U.S. trade deficit in goods with China totaled $347 billion in 2016, the second-highest deficit on record. In the first eight months of 2017, the goods deficit increased 6.2 percent year-on-year to $239.1 billion, with U.S. exports to China reaching $80.2 billion, an increase of 15 percent year-on-year, while imports from China grew 8.3 percent year-on-year to $319.3 billion. In 2016, the U.S. services trade surplus with China reached a record high of $37 billion, driven almost entirely by an increase in Chinese tourism to the United States.
China’s foreign investment climate continues to deteriorate as government policy contributes to rising protectionism and unfair regulatory restrictions on U.S. companies operating in China. The newly implemented cybersecurity law illustrates this trend. The law contains data localization requirements and a security review process U.S. and foreign firms claim can be used to discriminatorily advantage Chinese businesses or access proprietary information from foreign firms.
U.S. government efforts to tackle China’s trade-distorting practices continue to yield limited results. The inaugural Comprehensive Economic Dialogue, created following a meeting between President Trump and President Xi in April 2017, concluded with no concrete agreements or future agenda.
At the World Trade Organization (WTO), the United States continues to challenge China’s non-compliance with key provisions of its accession agreement, including failure to notify subsidies. In the past year, the United States requested WTO consultations over China’s management of tariff rate quotas for rice, wheat, and corn, and subsidies to select producers of primary aluminum.
CHINESE INVESTMENT IN THE UNITED STATES
Chinese government policies, coupled with increased investor uncertainty in China, have contributed to increased investment flows to the United States in recent years. In 2017, Chinese investment flows to the United States are expected to decline relative to 2016 as the Chinese government seeks to limit capital outflows and fend off risks from mounting corporate debt.
Sectors of the U.S. economy deemed strategic by the Chinese government are more likely to be targeted by Chinese firms for investment, while Chinese investments in nonstrategic sectors like entertainment, real estate, and hospitality are declining amid Chinese Communist Party efforts to limit capital outflows and reduce corporate debt.
Some Chinese firms seek to obscure their dealings in the United States through U.S.-based shell companies or attempt to drive down the value of U.S. assets through sophisticated cyber espionage campaigns. These firms are becoming more sophisticated in their attempts to circumvent Committee on Foreign Investment in the United States (CFIUS) reviews and other U.S. investment regulations.
Greenfield investments in the United States are not subject to the CFIUS review process, which may raise national security risks. Although the number of Chinese greenfield investments in the United States remains limited compared to acquisitions of U.S. assets, federal laws and screening mechanisms do not sufficiently require federal authorities to evaluate whether a greenfield investment may pose a national security threat.
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The opaque nature of China’s financial system makes it impossible to verify the accuracy of Chinese companies’ financial disclosures and auditing reports. Chinese businesses continue to list on U.S. stock exchanges to raise capital, despite operating outside the laws and regulations governing U.S. firms.
U.S. regulators have struggled to deter Chinese fraud schemes on U.S. exchanges, with Chinese issuers stealing billions of dollars from U.S. investors. Efforts to prosecute the issuers of the fraudulent securities have been unsuccessful, with Chinese regulators choosing not to pursue firms or individuals for crimes committed by Chinese companies listed overseas.
Some Chinese companies operate with little oversight under China’s opaque financial system, leaving U.S. investors exposed to exploitative and fraudulent schemes perpetrated by China-based issuers. Negotiations between the Public Company Accounting Oversight Board and its counterparts in China have resulted in little progress toward securing increased cross-border transparency and accountability.
U.S. ACCESS TO CHINA’S CONSUMER MARKET
China’s rebalancing to a more consumption-driven growth model should present opportunities for U.S. companies in the e-commerce, logistics, and financial services sectors. However, U.S. companies operating in China do not have a level playing field and continue to face significant market access challenges, including informal bans on entry, caps on foreign equity, licensing delays, and data localization policies.
China is the largest e-commerce market in the world, with e-commerce sales reaching $787 billion in 2016. According to the U.S. Department of Commerce, by 2019 an estimated one out of every three retail dollars in China will be spent online, the highest percentage in the world. Although China has traditionally provided the world with its manufactured goods, its e-commerce boom should offer increased opportunities for U.S. retailers and brands, with more and more Chinese consumers purchasing foreign goods. Demand is strong in areas where the United States excels, such as high-quality foods and supplements, beauty products, and healthcare-related goods.
Although China’s e-commerce market offers opportunities for U.S. retailers and brands, it is not without its challenges and risks. While the Chinese government has made some improvements in enforcing intellectual property rights, intellectual property issues remain a key challenge for U.S. companies operating in China. In particular, the prevalence of counterfeit goods on Chinese e-commerce platforms continues to hurt U.S. retailers and brands.
E-commerce has been a key driver of improvements to China’s $2.2-trillion-dollar logistics sector. Yet, China’s domestic logistics industry remains underdeveloped, due to the country’s historical focus on improving export logistics at the expense of domestic logistics infrastructure. This has caused logistics to become a major bottleneck for China’s e-commerce sector. China’s efforts to develop and modernize its express delivery industry could offer U.S. logistics firms like FedEx and UPS opportunities to expand their China operations.
Financial services have been a major driver of growth within China’s services sector, increasing 11 percent annually from 2012 to 2016. However, Chinese consumers’ access to financial services remains inadequate, and most Chinese consumers lack formal credit histories. Improving their access to financial services will be critical for raising domestic consumption levels. In addition, China has made limited progress in implementing reforms to improve the market orientation and efficiency of its financial sector.
Financial services are a mainstay of the U.S. economy and a major services export to China. While China has taken some steps to expand foreign firms’ access to its financial markets since joining the World Trade Organization, U.S. financial services companies continue to face significant market access barriers in China. These include informal and formal bans on entry, equity caps, licensing restrictions, and data localization requirements. China’s new cybersecurity law poses additional challenges for U.S. financial institutions operating in China. As a result, U.S. firms’ market share in China’s financial sector has been stagnant or declining in recent years.
China has become a global leader in financial technology. China’s Internet giants have emerged as significant players not only in e-commerce and logistics, but also in China’s financial services sector, particularly in payments and lending.
The Report Continues Tomorrow.